Macroeconomics

12 May 2015

The Great Rotation 

Financial analysts have long been predicting a ‘Great Rotation,’ a major switch by investors from bonds to equities, in response to two factors: high prices and low yields on government bonds, and growing confidence that economies worldwide are genuinely on the mend nearly a decade after the onset of the global financial crisis and ensuing downturn.

Last week, some people thought that the rotation had started. Yields of German and UK government debt were pushed higher by various factors, including a rebound in oil prices and the expectation – inaccurate, as it turned out – that the UK election would end in deadlock.

In fact, government bond prices quickly bounced back after data from the US, Germany and China, among others, suggested that it could be premature to conclude economic growth was returning to pre-crisis levels. As the euphoria fades, the value of government-backed debt again looks like a safe haven for nervous investors, even at near-zero yields.

What the episode does show is how far and how fast the financial markets can move when investors have a change of heart. It also highlights the fact that fixed-income investments continue to be shored up by the bond-buying programmes conducted by central banks, most recently Europe’s, to kick-start lacklustre economic growth – and that this quantitative easing cannot go on forever.

Uncertainty also remains about whether Greece can reach a deal with its creditors to obtain more financial help, and thus remain a member of the euro system – and the potential consequences if the talks fail. Volatility in the financial markets is an indication that the world’s economic worries have not yet been banished.